Flow-Driven ESG Returns

Abstract

I show that the performance of ESG investments is strongly driven by price-pressure arising from flows towards sustainable funds, causing high realized returns that do not reflect high expected returns. The coefficient linking ESG flows and realized returns is the product of two factors: The deviation of green funds' portfolios from the market portfolio and a flow multiplier matrix that is the inverse of the market's demand elasticity of substitution between stocks. Empirically, withdrawing 1 dollar from the market portfolio and investing it in the representative ESG fund increases the aggregate value of high ESG-taste stocks by 2-2.5 dollars. Under the absence of flow-driven price pressure, the aggregate ESG industry would have strongly underperformed the market from 2016 to 2021. Furthermore, the positive alpha of a long-short ESG taste portfolio becomes significantly negative.

Keywords: sustainable investing, ESG, price pressure, flows, demand elasticity

JEL Classification: G11,G12,G23